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Do Insurance Policies Have a Duty to Defend When a Crime is Alleged Against a Director or Officer?

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Do Insurance Policies Have a Duty to Defend When a Crime is Alleged Against a Director or Officer?

Do Insurance Policies Have a Duty to Defend When a Crime is Alleged Against a Director or Officer?

17Nov, 22

 When a business is sued, the business entity is usually covered by insurance that provides funds to defend the lawsuit and to pay a settlement or judgment.  Many times, however, such lawsuits include allegations or claims against the leaders of a business, usually directors and officers.  This is not surprising, as they are  often responsible for making difficult decisions on behalf of a company.

Directors and Officers Insurance (D&O) covers directors and officers when they make allegedly harmful decisions that expose their organization to lawsuits. The question then arises, how far does this protection go? Does a D&O Insurance policy cover the defense of the leaders of a business when the alleged conduct was criminal in nature?

Background on D&O Insurance Policies – California Directors and Officers Liability (D&O)

D&O Insurance protects a company’s leaders entrusted to make decisions on the company’s behalf if they are sued.

Liability claims against a company and its directors and officers are generally brought by stockholders, employees, or clients. Common types of allegations include allegedly bad investment decisions, acts of gross negligence, harassment, discrimination, and other unlawful activities.  The claims may go so far as to allege criminal actions by the directors and officers.

For an individual accused of such conduct, the consequences can be severe.  Beyond reputational damage, an individual may ultimately be held responsible for monetary damages or even be exposed to a criminal investigation that follows, or coincides with, the insurance litigation.

In such situations, D&O insurance helps ensure that individuals, and not just the company, are protected.  For example, D&O insurance protects the company’s corporate directors, officers, and even their spouses if they are personally named in a lawsuit. They, just like the company, may be considered the policy’s “insureds.”  As a result, D&O coverage is split into three parts: “Side A,” “Side B,” and “Side C.” With Side A coverage, the insurance company promises to indemnify individual directors and officers. Under Side B coverage, the insurance company reimburses corporate policyholders for losses indemnified by the company. The last, Side C coverage, is entity coverage, and it requires the insurance company to reimburse for liability arising from claims against the corporation.

Background on Insurance Companies’ Duty to Defend their Insured

 In California, D&O insurance policies often include two essential obligations to policyholders.  The first is the legal responsibility to pay legitimate expenses incurred under the policy. For example, an insurance company can be obligated to pay damages, judgments, and settlement costs related to the defense of claims and appeals.

The second is the insurance company’s “duty to defend.” Often expressly included in the policy terms, these provisions protect the insurer’s interests in the outcome of the suit. While the specific language of the “duty to defend” can vary, typically these provisions allow the insurer to choose the attorney and control the litigation strategy.  It is unsurprising that insurance companies prefer to control litigation strategy when it is ultimately the insurance company’s money that will be paying for the settlement or judgment resulting from the litigation.

Even if an insurance policy omits language requiring a “duty to defend,” it does not necessarily absolve the insurance company from the duty to advance the insured’s legal fees. While a judge will look to the terms of the policy, attorneys’ fees can qualify as a covered expense when the director or officer’s conduct is potentially covered by the policy. In addition, the insured does not necessarily have to definitively prove at the outset of litigation that the alleged claims are covered by the policy. When there is doubt as to whether the circumstances create a duty for the insurance company to pay legal fees, the law typically encourages courts to interpret insurance agreements in favor of the insured.

Ultimately, the insurer will often be legally obligated to advance legal expenses incurred by the director or officer. Further, the insurance company risks being held liable for breach of contract if it refuses to do so.

Insurance Companies Often Must Defend the Insured Even if the Insured is Accused of Committing a Crime or a Tort That May Be Excluded from Policy Coverage

 When there is a dispute about what is covered by a D&O policy, a court will first look at the language of the policy. Some policies include coverage for bad investment decisions, conflicts of interest, unauthorized data breaches, and other unlawful actions. However, coverage typically does not extend to intentionally illegal conduct. Some examples of intentional acts include slander or libel. Okada v. MGIC Indem. Corp.823 F.2d 276 (9th Cir.1986).

Still, an insurance company might be responsible for paying up front for expenses for both covered and uncovered claims –– at least until the issue of what is included in the policy coverage is resolved.

In one federal California case, for example, Alan Gon and other former officers and directors of the financial institution Gateway had allegedly engaged in “unsafe, unsound, and imprudent banking practices, which caused Gateway’s losses.” (Gon v. First State Insurance, 871 F.2d 863, 868 (9th Cir. 1989). First State Insurance Company argued that it had no duty to pay the legal expenses of Gateway’s former officers and directors because the policy lacked “duty to defend” language.  The insurance company also argued that several of the claims against the employees were excluded from coverage under the policy’s terms.

The U.S. Court of Appeals for the Ninth Circuit held that attorneys fees’ were defense expenses covered by the policy despite the absence of “duty to defend” language.  The court also noted the difficulty in parsing out claims covered by the policy from those that may not be covered. The court held, however, that neither the third-party that sued the officers nor the insurers should play the role of “arbiter” of the policy’s coverage at the outset because both have their own interests inconsistent with providing the officers with the benefits of the protection they purchased. The Court therefore held that it was proper for the district court to order the insurance company to pay all legal expenses incurred because apportionment between covered and uncovered claims was impractical at that early stage of the proceedings.  The court noted, however, that the insurance company would ultimately be entitled to recover fees paid for claims deemed uncovered.

At the beginning of a lawsuit, determining what is covered under a D&O policy is complicated. Even if you are alleged to have done something improper, an attorney can help protect your interests and work to ensure that your legal expenses are being covered at the outset instead of leaving the decision to an insurance company with an incentive to minimize its expenses.

At Delahunty & Edelman, we take a strategic approach in understanding our client’s business, professional, financial, and reputational interests when a crime is alleged against them.  This includes navigating the interplay between defending claims against a director or officer while coordinating insurance coverage and litigation of insurance claims.  For more information on how we can assist you, contact us today.

For more information

If you have been served with a subpoena to produce evidence or testify, contact our team today at at (415) 891-6210 for a complimentary consultation of your case.

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